What the Hell Is Wrong With This Market?

Not because the S&P 500 suffered its largest weekly drop in two years. And not because on Friday, the Dow sank 665.75 points, the biggest one-day drop since June 2016.

(That’s all trivia from a long-term perspective.)

No, it’s because everywhere I went – from a dinner party to the golf course to a Super Bowl get-together – friends kept peppering me with the same question.

“What the hell is wrong with the market?”

“Too much good news,” I told them.

How I wish I could provide photos here of the looks I got. But here – in a nutshell – is what happened last week…

We found out that January was the 88th consecutive month of job creation, the longest streak of continuous hiring on record.

This tightening labor market helped lead to the biggest annual increase in wages in eight years. Nationwide, average hourly earnings for all private sector workers in January were up 2.9%. (And the pickup in wages does not yet reflect the recent wave of announcements from companies that offered bonuses as a result of the new tax cuts.)

The news created fear that inflation may be stronger than expected. As a result, the yield on the 10-year Treasury note hit 2.85% on Friday. (It was near 2% in September.)

This caused investors to worry that the economy is so strong that the Federal Reserve may increase rates more aggressively than anticipated.

Dampening that expectation, however, is the fact that oil prices fell and the dollar rose last week. And there are good reasons to believe that neither move is temporary.

International investors shop currencies for yield the way CD investors shop banks for yield. U.S. rates are considerably higher than they are in Europe and Japan – and are almost certainly headed higher still. This will attract foreign investment capital and boost the dollar.

U.S. shale producers spent the last three years tightening costs and improving their efficiencies so they could make money at lower prices. Now they are set to flood the market with oil again.

In fact, they already are. In November, the U.S. Energy Information Administration announced that U.S. oil production exceeded 10 million barrels a day for the first time in nearly 50 years.

This will help push oil prices lower.

In short, last week’s market action – and Friday’s tumble in particular – was based on three factors:

The threat of higher inflation

The possibility of more Fed hikes

The longtime absence of a normal and healthy market shakeout.

As this morning’s market action clearly demonstrates, there will be more quakes and tumbles in the days ahead.

But let’s put all this in perspective:

Is the longest hiring streak on record good news or bad?

Is the biggest jump in wages in eight years good news or bad?

Is economic growth so strong the Fed may have to raise rates sooner than expected good news or bad?

Are the higher rates you’ll now earn on cash and bonds – including the reinvestment of mutual fund dividends – good news or bad?

And are lower energy prices and a stronger dollar good news or bad?

While you’re contemplating this, note also that nearly half the companies in the S&P 500 have reported fourth quarter results. More than 80% of them have beaten Wall Street’s revenue expectations, the highest percentage since the third quarter of 2008. (And the tax law will boost those profits further in the quarters ahead.)

Oh, and that 666-point “crash” in the Dow on Friday that punctuated a down week?

That means the Dow is now up only 27% over the past year.

If you have investor friends who are singing the blues, you may need the world’s tiniest violin to accompany them.

Good investing,

Alex

P.S. Last week’s market correction caused us to move my continuing commentary on “The Greatest Story That No One Knows” to this Friday. Stay tuned…